Short Sellers Target US Airways, Even With American Merger Cleared For Takeoff

Steve Schaefer
,
Forbes Staff
If you can put the word markets after it, I cover it.

US Airways/America West Airlines A320-231 at San Diego International Airport in San Diego, California (Photo credit: Wikipedia)

This is a guest post by Karl Loomes, market analyst at SunGard's Astec Analytics. The views expressed are those of the author.

US Airways Group has had a busy year, kicking off 2013 by confirming a merger with
AMR, which is set to form the world’s largest airline group with a combined equity value of $14 billion. However this story was not so clear cut, and in August this year the U.S. Department of Justice filed a lawsuit to block the merger due to anti-competition concerns, potentially throwing the whole deal into disarray.

This month however, the deal’s prospects seem to have taken a turn for the better after an agreement was struck—although as of yet not ratified by the courts—that will allow the merger to take place as long as the two companies allow greater access for low-budget airlines across many major U.S. airports. Meanwhile when the deal closes, each outstanding share of US Airways’ common stock will be exchanged for one newly issued share of American Airlines Group, which will trade on the Nasdaq with the symbol "AAL" and be run by current US Airways CEO Doug Parker.

The story is still far from over though. In a classic play of enthusiastic investment, LCC’s shares have been flying high this year, in large part on the prospects of the AMR merger. Perhaps surprisingly though, and less like the risk-averse investors we all know and love, when the justice department filed its suit, following an initial drop that eventually left shares 20% lower, the price began its upwards journey once again. As it stands, LCC shares are around double the $12.50 level at which they started the year.

So you might ask, this is all well and good, but what does the other side of the market think? What are short sellers doing?

Well, it would seem that short sellers have always been cautious of these share price gains, or at least thought there was money to be made betting against them. Indeed, data from SunGard’s Astec Analytics shows the number of LCC shares being borrowed (the prerequisite for short selling them) doubled long before the share price did – climbing from around 30 million at the start of the year to a peak at more than 65 million in May.

As you can see towards the end of this chart however, the short side seemed to have given up on this notion by the end of May, and borrowing levels began a turnaround that saw them retrace these gains entirely. Indeed, even after the news of the DOJ suit in August, and as the share price defiantly carried on its climb, borrowed volumes continued to fall – eventually to as few as 20 million shares.

In somewhat of a twist however, given the latest good news for the merger, those on the short side do not seem to be growing more optimistic of the company’s prospects, but exactly the opposite. Since the start of November, the number of LCC shares being borrowed has climbed at a much more rapid pace than the company has seen before, and now stands about 150 percent higher than at the start of the month. Although not yet at the levels seen when they peaked in May, this rapid increase could still have a story to tell.

But what is that story? It is not much of a stretch to suggest that if short sellers are taking out positions right now, they may be expecting the DOJ deal to fall through. However there are two key points to consider that stand against this idea:

Volumes began to climb before the news of the DOJ deal hit the market. If short sellers were betting against the gains made on this news, they pre-empted it by a week or two.

Although the levels have seen a very sharp increase in a short period of time, they are not yet at the highs seen in May (currently nearer to 50 million than 65 million). If short sellers were pessimistic then, why would they be more cautious of taking out positions at this much higher price?

And in that statement may be an answer. The short side may not be skeptical of the deal with the DOJ specifically, or the fact that a merger with AMR will help US Airways’ prospects, but rather they may simply be cautious that the share price is currently so high.

We observe the pattern time and time again—when those on the short side of the market feel a share price is overheated, they start to open positions. If the share price keeps climbing, they continue to open positions. This cycle usually ends one of two ways: either the share price hits a point where short sellers have to take a loss, or it falls and hits a point where short sellers take a profit. Or to put it in aeronautical terms, the short sellers will be proven right as LCC shares start to descend, or the stock will take off for even greater heights after the American deal is done.